The proposed changes have lead many people to suggest that Annuities are effectively dead.
Frankly, we think that’s rubbish and potentially dangerous.
For people who want a simple solution, with no investment risk or need for ongoing management and a relatively attractive return, an Annuity is likely to be the right option.
So, if you’re thinking of buying an Annuity, what effect will the changes announced in the Budget have on Annuity rates? Will they rise or fall? Should you buy now or wait?
We’ve asked some of the best pension brains for their view, but a few thoughts of our own first.
Reasons to think Annuity rates might rise
- The flexibility introduced by the Budget should mean we see a raft of new retirement income products launched. With greater competition from new products, insurers will need to make Annuities more attractive
- We should see a greater focus on Enhanced Annuities, which will push up rates for those people who qualify
- There is a general expectation that interest rates will rise later in 2014 or early in 2015, this should have a positive effect on Annuity rates
Reasons to think Annuity rates might fall
- The new flexibility will probably mean that those people with smaller pension pots simply take the lump sum, rather than buy an Annuity. It’s an unfortunate fact that people with smaller pension tend to have shorter life expectancies, removing small pots from the ‘Annuity pool’ will remove the cross-subsidy for people with longer life expectancies and could therefore push rates lower
- We expect to see fewer Annuity providers in the market. Less competition generally means a worse deal for the consumer
- Solvency II, a piece of proposed EU legislation is still lurking in the background. This could force insurers to keep larger reserves of cash, which mean they have to reduce Annuity rates
- If the economy stalls interest rates might not rise as expected
What do other pension experts think?
Andrew Tully, Pensions Technical Director, MGM Advantage: “The dramatic increase in retirement flexibility announced in the Budget means demand for Annuities is expected to fall. When the demand for goods falls, supply then drops, and the cost increases. So this should push Annuity rates down a little. More importantly, the pool of people buying Annuities may change in future. Previously many with small pots, who are likely to be less wealthy individuals with poorer life expectancy, would have bought an Annuity. Now many will cash in their pension. And there is a possibility wealthier people who have a family history of longevity will decide to buy an Annuity with some or all of their savings.”
“The possibility of these changes is likely to push rates down. This could be reversed to some extent in the competitive part of the market – primarily the underwritten market – as providers fight for market share. Overall, I believe the Budget changes will have a negative impact on rates. The unknown is how this ties together with other influencing factors. In particular, interest rates are likely to rise over the next couple of years, which should have a positive impact on rates.”
Tim Gosden, Head of strategy for Legal & General’s Individual Retirement Solutions business: “As far as pricing is concerned, our view is that that same challenges around investment strategy, mortality and underwriting that apply today, will apply next year. The fact that there may be far fewer smaller pots annuitising will not have much of a bearing on the actual rates. However, a smaller market means there is a possibility that there may well be fewer Annuity providers in the market, but we still anticipate a high level of competition.”
“Other points of notes are that, should interest rates improve this will have a beneficial impact on rates. And although at this point in time, we don’t know what the new regulations surrounding Annuities will be, we support the Government’s view that some consumers will still want a secure, regular income in their retirement, so annuities will continue to be a popular choice to meet this need.”
Mark Stoppard, Head of Product Development, Partnership: “With much still to be decided around pensions legislation, it is very difficult to definitively say that rates will increase or decrease or even just stay the same. What we can say is that for companies operating in the open market – such as Partnership – the core drivers of Annuity pricing are long term interest rates, mortality and provision of regulatory capital.”
“We do not anticipate that the announcements in the budget will have a material impact on these factors. However, as large insurers invest a significant amount into fixed-interest securities and the flow of funds is likely to fall – at least in the short term – we may well see higher long term interest rates and therefore more favourable Annuity pricing. That said, we believe that Enhanced Annuities will become a more common choice going forward.”
Henry Tapper, Pension Playpen and Director at First Actuarial: “Annuity rates will improve over the next year because interest rates will rise. This has nothing to do with budget reforms but will probably be attributed to Georg Osborne – especially as we have an election in May 2015.”
“The impact of the budget reforms is less clear.”
“Growth in annuity sales will be bulk annuity sales and we may see demand sharply increase as defined benefit schemes see de-risking as more attractive. The individual annuity market may be smaller but it will be more perfectly formed – we will see more informed purchasers and less hapless buying- this will sharpen rates as will the anticipated increase in pots being used to purchase annuities.”
“On the other hand, the number of competitive Annuity providers may well fall if overall demand drops, this would suggest a weakening of rates, especially in the impaired sector where provider financial strength is weaker.”
“We think the immediate impact of increased interest rates will mask the underlying trends (whichever way they go)”.
Ros Altmann, pension expert and campaigner: “In the past few years, Annuity rates have plunged – partly because interest rates have reached record lows and life expectancy has continued to rise – but also because insurers did not really face much competition for business. Their pension customers often just purchased an Annuity from their existing provider, at very poor rates, without shopping around properly for a better deal.”
“Once the market opens up and people have a choice as to whether they actually want to buy an Annuity, it is quite possible that rates will improve. Certainly, those companies that offered the worst rates in the past, should see a significant fall in their business and will either have to improve their rates, or see customers go elsewhere.”
“I expect that annuity rates could improve over time, but the full benefit of the reforms may not be felt until after April 2015, once the full freedoms are introduced. Between now and then, many people may still have to annuitise and will not receive any guidance to help them navigate their options. It is also likely that interest rates will start to rise by 2015 as well, so overall I would expect standard Annuity rates to increase over time. There are, however, some worrying signs that impaired life Annuity rates have been falling. It is far harder to compare enhanced rates directly, so it is possible that insurers are increasing profit margins on this area of the Annuity market to offset falling margins on standard business.”
So will rates rise?
The truth is no one knows for certain.
Our view is that competing factors will probably mean rates stay broadly the same over the next year.
If this is the case, anyone approaching retirement should not be rushed into making a decision, in the fear that rates will fall. But you should also remember the cost of delay, whilst being mindful of where your pension pot is invested should you choose to postpone any decision.